Study Unit 2: Cost Accumulations Methods Ronald Schmidt, CMA, CFM Jim Clemons, CMA

Part 1
Study Unit 2
Cost Accumulations Methods
Ronald Schmidt, CMA, CFM
Jim Clemons, CMA
Overview
Cost accounting systems record manufacturing activities using a
perpetual inventory system, which continuously update records
for cost of materials, goods in process and finished goods
inventory.
• Cost accounting systems accumulate cost and then assign

them to products and services.
• The two basic types of cost accounting systems are job order
cost accounting and process cost accounting.
SU 2.1 - Job Costing
• When companies produce customized products that

are separately manufactured, the production is
called job order productions or job order
manufacturing (also called customized production,
which is the production of products in response to
special orders).
• Production activities for a customized product

represent a job, which can apply to manufacturing or
service companies.
“A major aim of a job order cost accounting system is to

determine the cost of producing each job or job lot, the system
also aims to compute the cost per unit”
Required: Separate records for each job to accomplish this.

• Steps in Job-Order Costing

• Receipt of a sales order
• Predict the cost to complete the job – depends on product design
• Negotiate price and decide whether to pursue the job
– Cost-plus contracts – Customer pays the mfg. for cost incurred on the job
plus a negotiated amount or rate of profit
– Market factor prices
– Target cost
• Sales order is approved and production order is issued
• Cost are recorded by classification
– Direct Material
– Direct Labor
– Manufacturing Overhead – Charged is charged using an estimated rate.
Remember overhead costs support production of more than one job, and
include depreciation, factory supplies, supervision, maintenance,
cleaning and utilities.
Target Costing: Many producers determine a target cost

for their jobs. Target cost is determined as follows:
Expected selling price – Desired profit = Target Cost
If the projected target cost of the job as determined by

job costing is too high, the producer can apply value
engineering, which is a method of determining ways
to reduce job cost until the target cost is met.
• Job Cost Sheet
– General ledger accounts usually do not provide the
accounting information that managers of job order
operations need to plan and control production activities.
– Subsidiary records store information about raw materials,
overhead costs, jobs in process, finished goods, and other
items.
– Jobs cost sheets are separate records maintained for each
job. It identifies:
• Customer
• Job Number
• Product
• Key Dates
Continued
– Any costs incurred on the job are immediately

recorded on this sheet.
– When each job is complete, the supervisor enters
the date of completion and records any remarks.
– Factory overhead is also allocated (also termed
applied, assigned or charged).
Factory overhead consists of cost (other than

direct materials and direct labor) that ensure
the production activities are carried out.
• As a job is being produced, its accumulated

cost are kept in Good in Process Inventory.
• The summation of all cost sheets makes up a
subsidiary ledger controlled by the Goods in
Process Inventory account in the general
ledger.
• Cost Flows: During Production – While a job is being produced, its
accumulated costs are kept in Goods in Processed Inventory. The
collection of job cost sheets for all jobs in process makes up a subsidiary
ledger controlled by the Goods in Process Inventory account in the general
ledger. Managers use job cost sheets to monitor costs incurred to date and
to predict and control cost for each job.
• Cost Flow: Job completion – When a job is finished, its job cost sheet is
completed and moved from the jobs in process file to the jobs file. This
latter file acts as a subsidiary ledger controlled by the Finished Goods
Inventory Account.
• Cost Flows: Job Delivery – When a finished job is delivered to a customer,

the job cost sheet is moved to a permanent file supporting the total cost
of goods sold. This permanent file contains records from both current and
prior periods.
• Material Ledger Cards (files) are perpetual

records that are updated each time units are
purchased and each time units are issued for
use in production.
• When materials are needed in production, a
production manager prepares a material
requisition and sends it to the materials
manager.
• Labor cost from Factory Payroll account flow

to the subsidiary records of the job order cost
accounting system.
Factory Payroll and Factory Overhead should be

considered temporary accounts, which hold
various expenses until they are allocated to
balance sheet or income statements accounts.
• Factory overhead includes all production costs

other than direct materials and direct labor,
such as indirect material and indirect labor.
• They are recorded to the Factory Overhead
Control account, and ultimately to the job cost
sheets via an allocations.
• Overhead Allocation Bases

– Usually based on factors of productions like direct
labor or machine hours.
– Correct allocation is important and affects accuracy.
• Overhead Allocation Rates
– Predetermined Overhead rate or predetermined
overhead allocation (or application) rate.
The predetermined overhead rate is computed at

the start of the period and is used throughout the
period to allocate overhead to jobs.
• Overhead cost are “applied” to (or absorbed”

by) each job based on a predetermined
overhead application rate for the year. Three
step process:
1. Estimate total overhead for the year
2. Divide total overhead by allocation base
3. Apply based on number of allocation base units
used per job
• At the end of the period, the overhead control

and applied accounts are netted.
– If the results (balance) in the overhead control
account is a credit, then overhead was
overapplied.
Actual overhead > applied = Overapplied
Continued
– If the results (balance) in the overhead control

account is a debit, the overhead was
underapplied.
Actual overhead < applied = Underapplied

overhead
• The closer a estimate is to actuals in absolute terms

the better the estimates was
– If the variance is immaterial (with respect to the

company), it can be closed (charged off to) cost
of goods sold.
– If the variance is material, it should be allocated
based on the relative “weights” of work in
process, finished goods and cost of goods sold.
• It is important that you and understand the

“meaning” of over/under applied with respect
to net income and actual job cost.
• See Job-Order Cost Flow Diagram on page 56

• Spoilage
– Output that does not meet the quality standards
for salability is considered spoilage.
• That amount that is expected is considered normal
spoilage in which case it is included as product costs.
• Spoilage that is over or above normal is considered
abnormal and treated as period cost.
• Remember! You are expected to understand

the proper accounting for normal and
abnormal spoilage under both job-order and
process costing:
– In job-order costing, normal spoilage is treated as
a product cost while abnormal spoilage is treated
as a period cost.
– Consider what:
• System is being used, and
• Whether the product can be sold or not
SU 2.2 - Process Costing
Process costing is used in Process Operations,

also called process manufacturing or process
production, is the mass production of products
in a continuous flow of steps.
“Products pass through a series of sequential

processes”
• Process operations can also extend to

services, i.e. mail sorting.
• Common feature of Process Operations is that

it is “sequential” using a series of standardized
processes.
• Series of processes = series of steps

• Understanding processes for companies with

process operations is crucial for measuring
their costs.
• Job order costing system the focus is on the
individual job or batch.
• In process costing system focus is on the
process itself and the standardized units
produced.
• In process operations, each process is

identified as a separate production
department, workstation, or work center.
• Every subsequent department, workstation,

etc. receives the output of the previous “step”
(and is cumulative of all preceding)
• Additional cost added at each “step” can be

– Direct Material
– Direct Labor
– Overhead (labor, material and other)
– The last “step” produces the finished goods
– Output of one department becomes the input of

another department, as is the case with
sequential processing – costs transfer with those
units from the prior “step”
Remember!
Job order cost accounting systems assign direct material,

direct labor, and overhead to a “job”. The total job is then
divided by the number of units to compute a cost pre unit for
that job.
Process cost accounting systems assign direct material, direct

labor, and overhead to specific processes (or departments).
The total costs associated with each process are the divided
by the number of units passing through that process to
determine the cost per equivalent unit (EU) for that process.
In a process operation, the direct labor of a production
department includes all labor used exclusively by that
department. This is the case if the labor is not applied to
the product itself. If a production department in a
process operations, for instance, has a full-time manager
and a full-time maintenance work, their salaries are
direct labor costs of that process and are not factory
overhead.
A department's indirect labor cost might include an

allocated portion of the salary of a manager who
supervises two or more departments.
• Because of the machine-intensive nature of

process costing, direct labor tends to form a
smaller proportion of overall costs than under
job-order costing.
• Cost accounting under process costing
sometimes combines direct labor and
manufacturing overhead and treats them as
conversion costs.
• Process Cost Factory Overhead Cost

– The time it takes to process (cycle) products
through a process is sometimes used to allocate
costs.
– With increasing automation, companies with
process operations are more likely to use machine
hours to allocate overhead.
Equivalent Units!
If a process has no beginning and no ending goods in

process inventory, then the unit cost of goods
transferred out of a process is:
Total cost assigned to the process (direct material, direct labor, and overhead)
Total number of units started and finished in the period
• If a process has a beginning or ending inventory of

partially processed units (or both), then the total cost
assigned to the process must be allocated to all
completed and incomplete units worked on during the
period. Therefore, the denominator must measure the
entire production activity of the process for the period,
called equivalent units of production (or EUP).
• EUP = the number of units that could have started

and completed given the cost incurred during a
period.
The goal is to compute the cost per equivalent unit

and to assign costs to finished goods and goods in
process inventory.
• What complicates calculations is that material,

labor and overhead sometimes are added in
unequal increments over the process “steps”.
• Remember:
– First equivalent units are determined and then per-
unit cost are calculated.
• Two methods of calculating EUP (both are tested

on the exam!)
– Weighted-average method – units in beginning work-
in-process inventory are treated as if they were
started and completed during the current period.
– First-in, first-out method – units in beginning work-in-
process inventory are part of the EUP calculation. The
calculation is thus more complex than weighted-
average but tends to be more accurate.
Question 1
Question 1 - CMA1 Study Unit 2: Cost
Accumulation Systems
Levittown Company employs a process cost system

for its manufacturing operations. All direct
materials are added at the beginning of the process
and conversion costs are added proportionately.
Levittown’s production quantity schedule for
November is reproduced in the next column.
Question 1 (continued)
Work-in-process November 1
(60% complete as to conversion costs) 1,000
Units started during November 5,000
Total units to account for 6,000
Units completed and transferred out from

1,000
beginning inventory
Units started and completed during November 3,000
Work-in-process on November 30
(20% complete as to conversion costs) 2,000
Question 1 (continued)
Using the FIFO method, Levittown’s equivalent units for A. 5,000 units.
direct materials for November are
B. 6,000 units.
C. 4,400 units.
D. 3,800 units.
Question 1 Answer
Correct Answer: A
The computation of equivalent units for a period using the
FIFO method of process costing includes only the conversion
costs and material added to the product in that period and
excludes any work done in previous periods. Accordingly, FIFO
equivalent units include work and material to complete BWIP,
plus work and material to complete units started this period,
minus work and material needed to complete EWIP. Given
that all materials are added at the beginning of the process,
only those units started during November would have
received materials in that month. Because 5,000 units were
started, the equivalent units for direct materials equal 5,000.
Question 2
Question 2 - CMA1 Study Unit 2: Cost Accumulation Systems
• Superb Hancock Company uses a process costing system in which all materials are
added at the beginning of the first process. Conversion costs are added evenly
throughout the process. During the past month, 10,000 units were started in
production, and 8,000 were completed and transferred to the next department.
There were no beginning inventories. The ending inventories were 70% complete
at the end of the month. The company uses a weighted-average method for
inventory valuation.
• If Superb Hancock’s materials used in production cost $15,000 and its conversion
costs incurred were $25,000, what amount of inventory (rounded) was transferred
to the next department?
A. $32,000
B. $33,280
C. $36,280
D. $40,000
Question 2 Answer
Correct Answer: B
The equivalent units of materials equal 10,000 because all
materials are added at the beginning of the process, and
10,000 units were started. The equivalent units of
conversion costs equal 9,400 [8,000 units completed +
(2,000 units in ending inventory × 70%)]. The unit cost of
materials is $1.50 ($15,000 ÷ 10,000 EU). The unit cost of
conversion is $2.66 ($25,000 ÷ 9,400 EU). Thus, the cost
of goods transferred was $33,280 [8,000 units × ($1.50 +
$2.66)].
Question 3
Question 3 - CMA1 Study Unit 2: Cost Accumulation Systems
Superb Hancock Company uses a process costing system in which all materials are
added at the beginning of the first process. Conversion costs are added evenly
throughout the process. During the past month, 10,000 units were started in
production, and 8,000 were completed and transferred to the next department. There
were no beginning inventories. The ending inventories were 70% complete at the end
of the month. The company uses a weighted-average method for inventory valuation.
Assume that Superb Hancock uses first-in, first-out (FIFO) for inventory costing instead
of the weighted-average inventory valuation. If materials used in production cost
$15,000 and conversion costs incurred were 25,000, what amount of inventory
(rounded) was transferred to the next department under FIFO?
A. $32,000
B. $33,280
C. $36,280
D. $40,000
Question 3 Answer
Correct Answer: B
The only difference between weighted average and FIFO relates to the
beginning inventories. Because there were no beginning inventories in
this problem, the two valuation methods produce the same results.
The equivalent units of materials equal 10,000 because all materials
are added at the beginning of the process, and 10,000 units were
started. The equivalent units of conversion costs equal 9,400 [8,000
units completed + (2,000 units in ending inventory × 70%)]. The unit
cost of materials is $1.50 ($15,000 ÷ 10,000 EU). The unit cost of
conversion is $2.66 ($25,000 ÷ 9,400 EU). Therefore, the cost of goods
transferred using the FIFO method for inventory costing is $33,280
[8,000 units × ($1.50 + $2.66)].
2.3 Activity-Based Costing
“Activity-based costing (ABC) is a response to

the significant increase in the incurrence of
indirect costs resulting from the rapid advance
of technology”
ABC may be used by manufacturing, service, or

retailing entities.
2.3 Activity-based costing
• Under traditional costing system: OH is simply
dumped into a single cost pool
• Under ABC, indirect costs are attached to
activities and then rationally allocated
• ABC may be used by manufacturing service or
retailing
Traditional Costing System
• Peanut-butter costing = product-cost cross-subsidization

 inaccurate allocation of indirect costs over products or
service units
• DL + DM are traced to products/services
• A single pool of indirect costs is allocated based on a
single rate (overhead)
• Indirect costs from the pool are assigned using an
allocative (rather than a tracing) procedure, such as using
a “single” overhead rate for an entire department.
How much resources did I use to product X?

Steps in ABC process
1) Activity Analysis: understand the different
steps and process from DM to Finished Goods
2) Assign Resource Costs to Activities: first-
stage allocation. Identify resource costs: a
separate Accounting System may be
necessary to track resource costs separately
from the GL. Then we need to define resource
drivers to allocate it.
3) Allocate Activity Cost Pools to Cost Objects:
allocating the activity cost pools to final cost
objects = second-stage allocation
 What are my activity drivers?
Cost Drivers
• Cause-&-effect relationship
• Cost object may be a job, product, process,
activity, service or anything else for which a cost
measure is desired
• Process value analysis: Organization flow
– Value-adding Vs. Non Value-adding
– Product costing / continuous improvement
ABC used to obtain full-absorption cost (US GAAP)

ABC Advantages/Disadvantages
• Product costing is improved, better decision making

• Process value analysis (non-value adding activities can be removed)
• More cost assignment of OH
• Better cost control and more efficient operations
• Maintain a separate Accounting System to capture resource costs

• Design and implement drivers and cost pools
• ABC-derived costs of products or services may not conform with GAAP
• Cost of implementing an ABC system
Organizational Benefits
• Significant variance in volume, diversity of
activities, complexity of operations,
relatively high OH costs…
• ABC difficult for service organizations: high
facility-level costs hard to assign to service
• DL as a base for allocating OH
• No benefit for a single product and average
regular volume of activity
• Real benefits for high level of FC + wide
variety of products and level of production
SU 2.4 - Life-cycle costing
• Estimate revenues & expenses

• Over the entire sales life cycle
• Upstream costs (R&D, Design)
• Manufacturing
• Downstream costs (Mktg & Distribution,
Customer Service)
 Great value for Pricing Decision

Potential Benefits
• Relationships among costs incurred at different

value-chain stages
• Incurring costs vs. locking in costs (SUNK)
• Focus on cost control Vs. cost reduction
• After-purchase costs (operating, support, repair,
disposal…)
• Life-cycle and whole-life cycle  target costing
• Value engineering: minimize cost without reducing
customer satisfaction
Life-Cycle vs. Other Costing Methods
• Traditional approaches:
– Focus on cost control as opposed cost reduction.
– Treat pre- and postproduction costs as period
costs largely ignored in determining profitability.
– After purchase costs are ignored.
Continued
Life-Cycle vs. Other Costing Methods
• Whole-life is closely associated with life-cycle
costing.
• Life-cycle and whole-life are associated with

target costing and pricing.
• Value engineering is not lessening the quality,

it focuses on value-added and non-value
added.
Internal & External Reporting
• For external financial statement purposes,
costs during the upstream phase must be
expensed in the period incurred
• IFRS allows development costs to be capitalized
• For internal purposes, the costs (R&D) must be

capitalized in a life-cycle costing
• Organizations must develop an accounting
system consistent with GAAP
Advantage
• Better measure for evaluating the
performance of Product Managers
• Life-cycle costing combines all costs and

revenues for all periods to provide a better
view of a product’s overall performance

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Part 1

• Cost accounting systems accumulate cost and then assign

• When companies produce customized products that

• Production activities for a customized product

“A major aim of a job order cost accounting system is to

Required: Separate records for each job to accomplish this.

• Steps in Job-Order Costing

Target Costing: Many producers determine a target cost

Expected selling price – Desired profit = Target Cost

If the projected target cost of the job as determined by

– Any costs incurred on the job are immediately

Factory overhead consists of cost (other than

• As a job is being produced, its accumulated

• Cost Flows: Job Delivery – When a finished job is delivered to a customer,

• Material Ledger Cards (files) are perpetual

• Labor cost from Factory Payroll account flow

Factory Payroll and Factory Overhead should be

• Factory overhead includes all production costs

• Overhead Allocation Bases

The predetermined overhead rate is computed at

• Overhead cost are “applied” to (or absorbed”

• At the end of the period, the overhead control

Actual overhead > applied = Overapplied

– If the results (balance) in the overhead control

Actual overhead < applied = Underapplied

• The closer a estimate is to actuals in absolute terms

– If the variance is immaterial (with respect to the

• It is important that you and understand the

• See Job-Order Cost Flow Diagram on page 56

• Remember! You are expected to understand

Process costing is used in Process Operations,

“Products pass through a series of sequential

• Process operations can also extend to

• Common feature of Process Operations is that

• Series of processes = series of steps

• Understanding processes for companies with

• In process operations, each process is

• Every subsequent department, workstation,

• Additional cost added at each “step” can be

– Output of one department becomes the input of

Job order cost accounting systems assign direct material,

Process cost accounting systems assign direct material, direct

A department's indirect labor cost might include an

• Because of the machine-intensive nature of

• Process Cost Factory Overhead Cost

If a process has no beginning and no ending goods in

• If a process has a beginning or ending inventory of

• EUP = the number of units that could have started

The goal is to compute the cost per equivalent unit

• What complicates calculations is that material,

• Two methods of calculating EUP (both are tested

Levittown Company employs a process cost system

Units started during November 5,000

Total units to account for 6,000

Units completed and transferred out from

“Activity-based costing (ABC) is a response to

ABC may be used by manufacturing, service, or

• Peanut-butter costing = product-cost cross-subsidization